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October 23, 2022

Special note on stock market declines:

During market declines – with the constant barrage of market analysis and opinion on financial television, in newspapers, or through the Internet – it’s easy to get sucked into drama played out in the media.

That tends to drive fear.

But while the fearful start running out of the store when stocks go on sale, the best investors in the world, start running IN.

The fact is, the best investors in the world see declines in the U.S. stock market as an exciting opportunity. And so should you.

Most average investors in stocks are NOT leveraged. And with that, they should see U.S. stock market declines as a gift. The question should be: 'Do I have cash I can put to work at these cheaper prices? And, where should I put that cash to work?'

Billionaire Ray Dalio, the founder of the biggest hedge fund in the world, has said what I think is the most simple yet important fact ever said about investing.

'There are few sure things in investing … that betas rise over time relative to cash is one of them.'

In plain English, he’s saying that major asset classes, over time, will rise (stocks, bonds, real estate). The value of these core assets will grow faster than the value of cash.

That comes with one simple assumption. The world, over time, will improve, will grow and will be a better and more efficient place to live than it was before. If that assumption turned out to be wrong, we have a lot more to worry about than the value of our stock portfolio.

With that said, as an average investor that is not leveraged, dips in stocks (particularly U.S. stocks – the largest economy in the world, with the deepest financial markets) should be bought, because in the simplest terms, over time, the broad stock market has an upward sloping trajectory.

You don't have to pick the bottom. Just take advantage of discounts when you see them.

This is the very simple philosophy Dalio follows, and is the core of how he makes money, and how he has become one of the best and wealthiest investors alive.

Billionaires Bill Ackman and Carl Icahn, two of the great activist investors, lick their chops when broad markets sell off on fear and uncertainty.

Ackman says he gets to buy stakes in high quality businesses at a discount when broad markets decline for non-fundamental reasons.

Icahn says he hopes a stock he owns goes lower so he can buy more.

What about the great Warren Buffett? What does he think about market declines?

He has famously attributed his long-term investing success to 'being greedy when others are fearful.'

With this rationale in mind, I've just published an update on two stocks in our Billionaire's Portfolio.

One is the highest conviction stock in the portfolio of one of the great activist investors of the past twenty years. He has a third of his multi-billion portfolio in this one stock. It's a vital company in the multi-trillion dollar clean energy agenda. Wall Street just upgraded the stock, calling for 50% upside over the next twelve months.

The other update was on a technology company that owns the infrastructure critical to the success of 5G. If 5G is the future, it won't happen without this company. It's the second largest position in the portfolio of a billionaire value/activist investor with a nearly 50-year track record. Wall Street has a high price target on it 80% above current levels.

Add to this, we've recently added a new stock to our portfolio. It's the highest conviction position in the portfolio of one of the best biotech investors in the world.

Also involved in the stock is the best activist investor in the world. Both are very influential billionaire investors, with large stakes in the company, and are already pushing company leadership to unlock value in the stock. Wall Street has a high 12-month price target on the stock more than 60% higher than current levels.

If you're interested in these stocks, click here to join us, and I'll send you all of the details … plus you'll get access to our full portfolio of similar big-opportunity stocks, all owned by some of the most influential investors in the world.

If you're already a member, you can of course find all of the details in the member's area, here.

Pro Perspectives 10/21/22

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October 21, 2022

We've talked about the stress that rising global interest rates are putting on the global financial system, all being pulled along by U.S. monetary policy (and U.S. market interest rates).

The global financial system continues to show intolerance to higher interest rates, after a fourteen-year period of quantitative easing and zero interest rate policy.

First, it was Europe's sovereign debt market that was breaking, as U.S. 10-year yields were hitting about 3.30%. The ECB had to intervene to avert a sovereign debt crisis.

Then it was the UK bond market that broke. The Bank of England intervened to avert a financial system meltdown. The U.S. yields traded up to 4% when that UK bond market crisis was revealed (yet it was blamed on the new UK tax cut plan).

Today it was the Bank of Japan's turn. They intervened in the currency markets, defending the rapidly declining value of the yen.

This came after a 31% decline in the yen (on the year), relative to the dollar. And it came as U.S. yields surpassed 4%, and climbed over the past three days, unabated, to 4.34%.

Of course, the weak yen is driven by divergent monetary policies of Japan and the U.S.. Money moves out of Japan (zero interest rates), and into the U.S. for a favorable yield, which also encourages a yen carry trade — borrowing yen (virtually free), selling it and buying dollars and earning about a 4% interest rate spread.

What does it mean for markets?

The BOJ intervention this morning turned the tide of markets on the day: stocks higher, yields lower, commodities higher and the dollar broadly lower.

This also came with some Fed speak/news on the day, somewhat less hawkish than the drumbeat we've heard since the September meeting.

Nonetheless, this dollar chart, as we close the week, becomes very important.

If the dollar trend is over, it will breathe new life into commodities prices.

Pro Perspectives 10/20/22

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October 20, 2022

The 10-year yield climbed another 11 basis points today, nearly touching 4.25%.

That puts it 117 basis points above the Fed Funds Rate (the overnight interbank lending rate set by the Fed). This signals a bond market that believes the threats the Fed has been making all year.

What's the threat? The Fed is threatening to keep hiking rates until they bring inflation back to their target of 2%.

Interestingly, it was just two years ago that the Fed made "signficant changes" to it's monetary policy framework (here). They adjusted their "target" level for inflation to be, an "inflation that averages 2% over time."

This was the Fed's response to an inflation rate that ran persistently UNDER 2% throughout the post-financial crisis period.

They said, "following periods when inflation has been running persistently below 2%, appropriate monetary policy will likely aim to achieve inflation moderately above 2% for some time."

What happened to this strategy?

No one on the Fed is talking about this. They continue to say, definitively, they will bring inflation back to 2%. In fact, there aren't even dissenters among the Fed Board of Governors, about the current path, nor the talking points. That's very unusual, historically, to have a Fed all in agreement, all toeing the line, especially in such a complicated time.

Let's take a look at what this "average" inflation number looks like.

Below is the Fed's favored inflation measure, core pce. You can see it ran about 1.5% on average in the post-GFC period. Post-covid its run about 3%. If we narrow it to the Biden administration, it's running an average of 4%.

If we average the annualized monthly core pce dating back to the failure of Lehman Brothers, we get 1.85%.

With the above in mind, should this inflation be unwelcome by policymakers?

As you can see in the next chart, it's doing the job they want it to do. Deflating the value of a very high debt burden (the far right of the chart, finally declining).

Pro Perspectives 10/19/22

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October 19, 2022

The U.S. 10-year yield closed today at 4.13%.

That's well above the 4% level, which has proven to be a level that reveals damage in the global financial system. And the close today is 12 basis points above any close we've seen to this point (in this rate cycle).

Remember, especially in this post-Global Financial Crisis and Post-Pandemic world, rising U.S. rates moves the anchor for global interest rates — higher.

It took a breach of 3.30% in the U.S. 10 year, back in June, to put Italy (and the fiscally weak spots in the euro zone) on sovereign debt default watch. The European Central Bank had to gather, in an emergency meeting, and devise a new bond buying plan to put a lid on sovereign bond yields in Europe — to avert another sovereign debt crisis.

The first breach of 4% in U.S. yields (in this rate cycle) was on September 28th.

That day was also the culmination of a 135 basis point, five day run-up, in the UK's 10-year government bond yield.

That move, those rate levels, revealed UK pension funds to be on a quick path to insolvency. The Bank of England had to intervene, to avert a financial crisis (which would have been global).

So now we have another new gap higher for the world's benchmark interest rate to digest. Thus far, the central bank backstops provided in the euro zone and in the UK are keeping bond yields in those respective areas under control.

Where will the next vulnerability lie for the global financial system? We will probably find out, soon.

As we've discussed dating back to early this summer, when the Fed was beginning to move rates, and when they announced quantitative tightening plans, "history tells us that unforeseen consequences will follow (i.e. something will break in the financial system)."

The Fed seems determined to break something.

The good news: History also tells us that the Fed (and other central banks) will respond, with backstops, guarantees, more QE. "Whatever it takes."

Speaking of market manipulation, let's talk about energy.

Bad energy policy-making from Western politicians has choked off investment in new oil exploration and production, and regulated away incentives to produce — which has led to structural supply problem.

Add in curtailed supply from a global producer, like Russia. And cede control on global oil prices to OPEC, via less competition — and you get guaranteed higher energy prices.

What do the politicians do? They don't change policy, they opt for short term price manipulation.

The UK government has capped prices on energy for households and businesses. European Union politicians have their hands all over the energy markets, working on plans to subsidize, backstop and outright control prices in Europe. And in the U.S., the President just released the last tranche of oil from a 180 million barrel drawdown of the Strategic Petroleum Reserves, in efforts to keep a lid on oil prices. That's a 28% total drawdown, and the administration left open the option to do more early next year.

The moral of the story here: The crises of the past fourteen years have resulted in central banks and governments crossing the lines of what was deemed to be acceptable engagement in free markets. They don't go back. They only become more emboldened.

Pro Perspectives 10/18/22

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October 18, 2022

As we discussed the past few days, the banks kicked off Q3 earnings season with solid numbers, and solid reports on the health of businesses and the consumer.

Today, we had more evidence of solid economic activity in the third quarter.

Johnson and Johnson beat on earnings and revenues. United Airlines had the strongest earnings in three years. The CEO called it "the best operational quarter in company history." And Netflix crushed estimates after the close today. Reed Hastings called the first half "challenging," but said now they believe they are "on a path to reaccelerate growth."

It's still early, but so far the retrenchment in S&P 500 earnings that the Wall Street doom and gloomers have been looking for, isn't happening.

Add to this, this morning we saw reports on industrial production and capacity utilization for September — both strong.

Let's take a look at Industrial Production …

Each of the dips in this chart, below zero, was associated with recession, with the exception of 2015 — which was associated with the expectations of the Fed's exit of GFC emergency policies (i.e. rate hikes).

As we move to the right of the chart, despite two consecutive quarters of negative real GDP, AND (related) the Fed's exit of emergency policies, the industrial sector of the economy is performing well!

Remember, as we discussed yesterday, nominal growth is hot, running at an average annual rate of 8% (averaging the quarterly annualized growth of the first three quarters). This is what happens when you grow the money supply by 40% in two years (10 years worth of money supply in two years)!

And with an explosion in money supply, particularly when you put money directly into the hands of consumers, you also get a reset of prices.

We've see it. The level of prices has reset. And the rate-of-change in prices is now moderating.

The Fed has successfully manipulated down inflation. They've done it by talking down the stock market and threatening a Paul Volcker-like inflation fighting campaign. That has crushed the exuberance in the economy, but not the activity — as we can see in the earnings, industrial sector, and in nominal growth.

With the exuberance taken out of the economy, housing prices have started to fall. Rents have started to fall. Used and new car prices have started to fall. Even global food prices (the FAO food price index) have fallen for five consecutive months.

If we get a split Congress next month (some well needed gridlock), we may have a formula for a period of hot growth and more moderate inflation.

Pro Perspectives 10/17/22

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October 17, 2022

With the Bank of American earnings report this morning, we've now heard from the four big banks, on Q3 earnings.

Bank of America beat on revenues and earnings. As we discussed Friday, where the banks are losing on investment banking activities (due to low confidence in the market and economic outlook) and wealth management (lower fees from lower account balances), they are making on trading revenue (market volatility brings more trading volume) and a very healthy interest rate spread (where they borrow, and what they pay you on your deposits).

Moreover, the big banks continue to say that consumer and business balance sheets are healthy, consumers have the appetite to spend, and jobs remain plentiful.

This doesn't exactly support the mood of the market.

Keep in mind, while the Fed has talked down the stock market and has tried to talk UP unemployment, the nominal growth rate of the economy is running at the hottest pace since the early 80s. Before the effects of inflation, the economy grew in the first quarter at a 6.6% annual pace, in the second quarter at 8.2%, and the third quarter is projecting over 9% annual rate at the moment (according to the Atlanta Fed GDP model).

With all of the above said, by the end of the week we will have heard from about 20% of S&P 500 companies on Q3 earnings. Will the fundamentals match the performance of financial markets?

To this point, investors in a traditional 60% stock/ 40% bond portfolio are suffering from the worst performance on record (down 30%). The next closest year was 1931. And those two economic environments don't compare well.

With that, are markets overestimated the risk that we are heading for a major economic shock and calamitous fallout? If so, I would argue markets are underestimating (if not misunderstanding) the role that central banks and governments, of the Western world, have taken (their mantra: "whatever it takes"). They are in full manipulation mode, intervening with monetary or fiscal policy wherever needed. We've already seen plenty of it, just in the past few months, both government and central bank backstops.

Pro Perspectives 10/14/22

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October 14, 2022

We ended the week with the big banks kicking off Q3 earnings season.

Revenues are up (and better than estimated), for three of the big four banks that have reported thus far.

And earnings came in better than expected, but broadly lower than a year ago (exception Wells Fargo).

As we've discussed in the past, the banks are "heads they win, tails they win" businesses. When times are unstable over the past fourteen years, they've been backstopped by the Fed (de-risked), and incentivized to fuel credit creation to help the economy — from which they make money in loan origination, investment banking and trading.

When times are more stable, their customer account balances balloon (as they have now), from which they get to earn an interest rate spread from the rising interest rate environment.

And now, a less stable time, but with rates rising from a long period of zero interest rates, the banks are cashing in on a very healthy interest rate spread. They are very slow to move from paying practically nothing on deposits, while earning over 3% now from the Fed.

As we move into next week, and hear more on corporate earnings, we'll do so with the stock market trading off of a new low for the year, marked yesterday. And with a forward P/E on stocks that has come down from north of 20 (at the beginning of the year), to just 15.5. The long-term average P/E on the S&P 500 is 16.

So stocks have fallen for three consecutive quarters, evaporating the premium to the long-term valuation multiple on the stock market.

Moreover, as of yesterday's lows, we were less than 3% away from fully retracing to the pre-pandemic levels.

Yet we have $6 trillion of new money in the economy (additional money supply), since the pandemic. Unemployment is at record lows, and interest rates (still) are at slightly lower than long-run average levels.

The fundamentals don't match the market behavior. Clearly there is stress in the financial system. But policymakers have shown us, they will do whatever it takes to maintain stability. We should expect intervention, where needed. Again, in their own words: "Whatever it takes."

Stocks are cheap. And among the broad market, banks are very cheap, trading at single digit forward P/Es, well below the 5-year averages.

Pro Perspectives 10/13/22

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October 13, 2022

The September inflation came in hotter this morning (more in a moment).

Stocks went down. Yields went up.

Then it all reversed.

Once again, the 4% area in the 10-year yield, the benchmark of the government bond market, seems to be the line in the sand.

As we’ve discussed often in my daily notes, this liftoff phase of global interest rates, where central banks have been exiting emergency policies, has been led by the Fed. And a rise in U.S. rates, moves the anchor for global interest rate.

With that, as the U.S. 10-year yield hit 4% in late September, it dragged higher government bond yields, and it resulted in a shock in the UK government bond market, which required intervention from the Bank of England.

So, here we are heading into today’s big inflation report, with the 10-year around 4%.

Again, the inflation data for September was hotter than expected, and the 10-year yield had a quick visit to 4% and reversed.

Stocks reversed as well, and that turned into another historic moment for the stock market.

Remember, last week, we saw one of the biggest two-day gains in stocks. And we looked at this chart …

Looking back through all of the two-day returns in the S&P 500 futures, dating back to 2006, a two-day return of over 5% is rare, and every time since 2006, it has been fueled by policymaker intervention, to respond to a significant risk to, or destabilization of, the global financial system. These were all significant moments in the history of markets.

As such, the big 5%+ bounce in stocks last week was (also) intervention-driven, as the Bank of England intervened in the UK bond market to stabilize the UK financial system. Again, given the comparables in history, we can draw the conclusion that this UK bond market event was a very significant threat to the global financial system.

Now, let’s fast forward to today, and again we have another rare occurrence. The S&P futures plunged 2.6% after the inflation data, and then surged to close up over 2% for the day. It was on a 5.4% trading range.

I went through 25 years of S&P futures data that have this magnitude of trading range, or greater in common. And like the two-day return study, these extraordinarily large trading range days (finishing up or down) also come associated with very significant moments.

As you can see in the chart above, these ranges are associated with major market crises, policymaker intervention, policy change (via elections/votes) and market liquidity crises.

The past two, however, have come as the result of an inflation report (and have come in consecutive months)!

What do we make of it?

Remember, high inflation environments, historically, have only been resolved when short term rates (the rates the Fed sets) are raised above the rate of inflation. The Fed remains well below the rate of inflation.

Why? As we’ve discussed along the way of this Fed tightening path, even if the U.S. economy (including our government’s ability to service its debt) could withstand the pain of high interest rates, the rest of the world can’t. And we’re already seeing, at current interest rate levels, that the global financial system can’t withstand it.

That’s why this 4% level in the 10-year yield seems be a vulnerable point. And that’s why this inflation report, has become the equivalent of a major market moment in recent history.

The good news, as we discussed yesterday, some of the hot spots in the inflation report, are cooling (new cars and rents), though it didn’t show in today’s report.

If fact, even if prices continued to move at the pace of the past three months (the three-month average monthly headline inflation) we’re looking at an inflation rate that is running around 2% annualized — which is the Fed’s inflation target.

And if that’s the case, we could be looking at a collapse in inflation by next year, as most of the effect of the 300 basis points of tightening has yet to be felt in the economy (still lagging).

So, how would 2% inflation be possible (much less lower), if the Fed Funds rate is still (at the moment) well below the 8.2% current annual inflation rate that we see in the media reports (which measures prices now against prices of a year ago)?

Arguably, the Fed has done its job, slowing the economy and lowering inflation (which is showing up in the monthly inflation change). They’ve done it by destroying confidence and destroying stock market wealth. And that’s been accomplished mostly through tough talk.

Why is that good news? Perhaps the pain has already been inflicted, on the stock market and the bond market.

Pro Perspectives 10/12/22

October 12, 2022

The September inflation report comes tomorrow morning.

Let’s take a look at what stocks have done since the last inflation report.

Chart Description automatically generated

It’s been straight down. The report itself sent stocks into a 4.8% slide (peak to trough) for the day, on September 13.

This was all on the view that it would force the Fed to do more (more rate hikes). Indeed, they’ve certainly threatened to.

So what was so bad about the last inflation report?

First, the headline number (this was data from the month of August) was up just 0.1% compared to the prior month. At that monthly pace, inflation would be running just a bit over 1% annualized. That’s very, very tame inflation.

But it was the uptick in the inflation number excluding the effects of food and energy that spooked markets. That ticked up from 5.9% to 6.3%, year-over-year.

It was shelter that accounted for about 40 percent of that increase.

Other drivers of that increase in the core inflation number: healthcare costs, new vehicles, used cars and trucks, and household furnishings.

Let’s take a look at what we know about those components, for clues on what tomorrow’s number might look like.

If we look at the recent data released by Kelly Blue Book on new car prices in September: It was the first decline in five months.

What about used cars? The Manheim used car index showed a 3% decline in used car prices in September compared to August.

For healthcare, the U.S. Health Care Price Index (which measures cash price paid for healthcare) declined in September.

Remember, shelter was the hottest component in the last report. What did shelter prices do last month? Realtor.com says median home prices peaked in June. And the Apartment List National Rent Report says the national month-over-month rents were down by 0.2% (chart below).

Chart, histogram Description automatically generated

Rent has been a key contributor to overall inflation. Both CNBC and Bloomberg are running headlines today, calling for a hot number tomorrow, driven by rents. We’ll see tomorrow if the fastest growing rental market place in the United States has a better handle on rents than Wall Street media.

Add to all of this, gas prices were down 7% last month, for the third consecutive month.

Pro Perspectives 10/11/22

October 11, 2022

The U.S. bond market was closed yesterday. And yet we entered today with a spike back to the dangerous 4% level in the 10-year yield.

It was just two weeks ago that the combination of the global benchmark for interest rates (U.S. 10-year Treasuries) at 4% and the global benchmark for stocks (the S&P 500) back at the lows of the year, was creating stress in the global financial system. It looked like a breaking point.

And it was. The next morning, the Bank of England (BOE) was forced to rescue failing UK pension funds.

As Warren Buffett has said, “only when the tide goes out, do you discover who’s been swimming naked.” The “tide” in this case, is the easy money, low inflation era.

With higher rates, UK pension funds have been exposed as overleveraged and dangerous to the UK government bond market. As the value of UK government bonds (gilts) were falling (rates rising), these funds were getting margin calls, where they were forced to sell bonds. The forced selling, resulted in lower bond values, which resulted in more margin calls, which resulted in more bond selling (and a self-reinforcing global sovereign debt spiral was underway).

It has now been revealed that these massive pension funds were just hours from insolvency, which would have quickly spilled over into the UK financial system, which would have quickly become a problem for the global financial system, and global sovereign debt markets.

With that, we close the day today with a very important comment from the head of the Bank of England.

There has been speculation that the BOE will continue to absorb the stress in the pension funds, and where ever else it might emanate in the financial system – for as long as it takes.

But the BOE Governor rejected that today, warning the pension funds that they have three days to fix themselves, using the liquidity provided by the BOE.

This comment sent U.S. markets back to the worst levels of the day, and back around the danger levels of two weeks ago.

This comes as the Fed continues to march officials out in front of the media with hawkish rhetoric.

And this comes just two days ahead of the very important U.S. CPI number.

So, the current level of global market interest rates are already proving to create stress in the global financial system. Meanwhile central banks (led by the Fed) continue to talk about responding to hot inflation data, with even higher rates.

What if the inflation data on Thursday is hot?

Keep this in mind: The Bank of England (and the Fed) are responsible for maintaining stability in the financial system.

The BOE is talking to UK pension funds as if they are in a position of strength.

They are, right now, the “buyer of last resort,” in the UK bond market. They are in a position of weakness. And we’ve already seen what that looks like. They’ve been forced to come off of the sidelines, and return to the business of emergency policies (QE).

As the old adage goes, if you own the bank $100, you have a problem. If you owe the bank $100 million, the bank has a problem.